Introduction and the Payback Period Approach

Question 1

Identify the disadvantages of the payback period approach to project evaluation.

Answer 1

1. Ignores the time value of money
2. Ignores cash flows received after the payback period
3. Does not measure total project profitability
4. Maximum payback period may be arbitrary

Question 2

Describe the payback period approach to project evaluation.

Answer 2

Determines the number of years (or other periods) needed to recover the initial cash investment in the project and compares the resulting time with a pre-established maximum payback period. Uses undercounted expected future cash flows.

Question 3

Under what circumstances would the payback period approach to project evaluation be most appropriate?

Answer 3

1. When used as a preliminary screening techniques

2. When used in conjunction with other evaluation techniques

Question 4

Identify the advantages of the payback period approach to project evaluation.

Answer 4

1. Easy to use and understand
2. Useful in evaluating liquidity of a project
3. Use of a short payback period reduces uncertainty

Question 5

Identify five different techniques for evaluating capital budgeting projects.

Answer 5

1. Payback period approach
2. Discounted payback period approach
3. Accounting rate of return approach
4. Net present value approach
5. Internal rate of return approach

Question 6

Identify a technique that is intended to rank capital budgeting projects in terms of desirability.

Answer 6

The profitability index (PI)